U.S. Needs a National Safety Board for Financial Crashes

May 28 (Bloomberg) -- There are growing concerns that the
regulatory bodies overseeing the financial sector are incapable
of understanding, preventing or even properly investigating
excessive risk taking that threatens to ruin the economy.

This issue was raised before the 2008 financial crisis and
received more attention during the debate that led to the 2010
Dodd-Frank financial-reform law. Some tweaks were made in
various parts of the regulatory apparatus, including the
governance of the Federal Reserve Bank of New York, to reduce
the influence of Wall Street.

In light of the $2 billion-and-counting trading losses at
JPMorgan Chase & Co., the issue is back on the table. If
anything, the key points have been sharpened both by what we
know and don’t know about JPMorgan’s losses. It is time to
consider establishing the equivalent of a National
Transportation Safety Board for the financial sector, along the
lines suggested by Eric Fielding, Andrew W. Lo and Jian Helen
Yang. (Andrew Lo is my colleague at the MIT Sloan School of
Management.)

In 2008, many things went wrong to create a true systemic
crisis. The Financial Crisis Inquiry Commission spent a great
deal of time poring over the details; in the end its conclusions
split along party lines. In my assessment, deregulation allowed
big financial companies to take on and mismanage excessive
risks. They blew themselves up at great cost to the economy, and
then received arguably the most generous bailout in history.

High-Profile Trading Unit

I blame the regulators and the banks, and the ways in which
the latter captured the hearts and minds of the former (as well
as politicians of both parties). Other people, particularly
those who like such firms, disagree -- and prefer to put the
entire onus on the regulators.

The JPMorgan trading losses of 2012 are much more specific
and focused. We know that something went badly wrong in a high-profile trading unit, staffed with people who were considered to
be the best in the business. We know that Jamie Dimon, the chief
executive officer, approved in general what was happening, yet
appears not to have been informed about key decisions.

We don’t know the exact nature of the initial mistake or
mistakes. We don’t know the details of reporting within the
JPMorgan management structure. And we also don’t know what Dimon
knew and when he knew it. There are press accounts on all these
points -- with some stories appearing to contain more or less
guidance from JPMorgan’s public-relations team.

In essence, a serious accident occurred at JPMorgan. Or we
might call it a “near miss” in terms of systemic implications.
Major banks don’t fail in benign periods, and this isn’t the
worst quarter in recent memory, nor the worst we are likely to
face in the near future. (I’m thinking of a rolling series of
likely debacles in the euro area.)

It is in the public interest to have a proper, independent
investigation of the losses at JPMorgan. But here we run into a
number of practical and political difficulties.

First, the obvious parties to conduct an investigation are
also the regulators and supervisors of JPMorgan -- and thus face
a potential conflict of interest. Would the Securities and
Exchange Commission, the Commodity Futures Trading Commission,
the Office of the Comptroller of the Currency or the Federal
Reserve really want to uncover and explain what they previously
overlooked?

The Federal Bureau of Investigation has launched a probe,
but its focus is presumably on whether to bring charges, rather
than to figure out how to make the financial system safer. The
Office of Financial Research, established by Dodd-Frank to
monitor financial risk in the larger picture, so far has had no
discernible effect.

Political Connections

Second, Dimon has the best possible political connections,
including at the White House, where one of his former
executives, Bill Daley, was until recently the chief of staff.
Dimon also sits on the board of the Federal Reserve Bank of New
York, a supervisor of large banks and the source of expertise on
financial markets within the Federal Reserve system.

There is an active debate in and around official circles
about whether Dimon’s position on the New York Fed creates the
perception of a conflict of interest, or worse, the reality.
Even Treasury Secretary Timothy Geithner suggested recently that
Dimon should resign from that role. This is striking given that
Geithner isn’t known to be unfriendly to very large banks.

If the CEO of an airplane manufacturer or a major airline
sat on the NTSB board, would that make you more or less
concerned about the safety of air travel? The board is a
federal agency charged solely with investigating transportation
accidents. Its members are appointed by the president, subject
to confirmation by the Senate. Board members can’t be executives
or employees of airline or other transportation-related
companies. They are also not allowed to have any financial
interest in such companies. (All these details and more are in
the paper by Fielding, Lo and Yang.)

At the same time, the board members have long and relevant
work experience. Their biographies are impressive. They have
substantial political, regulatory, industry and practical
experience (at least three are pilots, but I’m also impressed
that the chairman is licensed to drive a school bus). One board
member is an expert on human fatigue.

In most parts of U.S. public life, we care greatly about
governance. This makes sense, given that the U.S.’s legal
tradition is partly based on a long-standing and well-founded
suspicion that strong executives can behave in an irresponsible
and socially damaging manner. That was, of course, the problem
the Founding Fathers had with King George III -- and a
perspective that motivated and informed the Constitutional
Convention of 1787.

The board is a small agency (about 400 employees). Its area
of expertise is disaster investigations. It also consults widely
with all relevant parties after a crash or similar event,
including with the people who built and operated the relevant
systems. But there are clear rules regarding transparency for
both the reporting of facts and deliberation of what happened
(again, see Fielding, Lo and Yang for the details).

We need finance to run a modern economy, just as we need
transportation. Finance has become more complex and more prone
to major disasters; just ask JPMorgan shareholders. We should
learn from accidents and mistakes and figure out how to make the
system safer.

The point isn’t to eliminate risk from the financial
sector, air travel or our lives; that is impossible and a fool’s
errand. But we should better understand those risks and how to
control them. When the supposedly best risk managers on Wall
Street suddenly announce billions of dollars in unexpected
losses, we need to know exactly what happened and why.

(Simon Johnson, a professor at the MIT Sloan School of
Management as well as a senior fellow at the Peterson Institute
for International Economics, is a co-author of “White House
Burning: The Founding Fathers, Our National Debt, and Why It
Matters to You.” The opinions expressed are his own.)

Today’s highlights: the View editors on uncertainty and the
economy and staving off war in Sudan; Ramesh Ponnuru on the
U.S.’s flawed trade policy; Betsey Stevenson and Justin Wolfers
on the next debt-ceiling debate; Chip Jacobs on California
Governor Jerry Brown’s green-energy plans; Roger Lowenstein on
risk and hedging.